A move out of the short end of the market and into longer-dated paper helped the 30-year bond outperform other issues in thin trading yesterday.
The 30-year ended the session up 1/8 of a point, to yield 6.55%.
Volume was extremely light yesterday as the market remained in a period of consolidation ahead of economic news later in the week, including the employment report for July and the Federal Reserve's "beige book" report of economic conditions.
Several factors conspired to hurt short-dated securities and prompted yield curve flattening trades, which helped the long bond improve.
A Wall Street Journal article that questioned last week's price rally against the backdrop of expectations for higher short-term interest rates sent a sobering blow to the market.
The Journal story, coupled with one in Forbes predicting a 50 basis point rate hike after a budget plan is passed, helped prompt the move out of the short end.
European central banks were reported to be big sellers of bills and short-dated coupons. Currency volatility in Europe, which has helped Treasuries in recent sessions by making the market a safe haven, failed to boost the U.S. unit as much as investors expected and made U.S. government securities less attractive to foreign accounts.
Concerns over the health of the deficit reduction package also turned some buyers into sellers.
Most expect a final proposal for the package will be voted on later this week, but rumors about a congressional logjam circulated in the market throughout the day and were met with alarm by investors.
"Last week people bought up a lot of securities and they're getting rid of some now," said Steven Wood, director of financial markets research at Bank of America in San Francisco. "I don't think there's much money on the sidelines at this point to buy securities."
The five-year and seven-year notes were hit hardest by yesterday's price action as retail and speculative accounts moved to extend maturities. Traders said that lack of buyers in the short and intermediate sectors of the curve contributed to the market's decline.
Prices received some help early in the session from the manufacturing sector. The National Purchasing Managers' survey of business conditions confirmed the market's view that the economy remains on a slow growth path and that price pressures are minimal at best.
The overall index improved marginally in July to 49.5, from 48.3 in June. But the market keyed off of the detail of the report, which traders said gave participants more confidence to move out on the yield curve.
"These numbers suggest the economy is meandering along on a 2% growth track," said Jay Woodworth, senior domestic economist at Bankers Trust Co. "Putting the June and July numbers together is another indication that industry is hurting."
Kenneth Mayland, chief economist at Society National Bank in Cleveland, read similar weakness into the release. "Manufacturing is still dead in the water," he said.
Mayland said the economic data schedule is skewed toward the latter part of the week when the Labor Department releases the employment report for July.
"The employment numbers will be extremely important this week as the markets are looking for a reading on the direction of the economy and interest rates," he said.
That view underscores a growing fear that despite last week's lackluster gross domestic product report and the fact that inflation remains well-behaved, the Fed may soon tighten rates.
A growing number of analysts believe that last week's GDP report understated economic activity in the second quarter. Observers pointed to strength in the final sales component and the large drop in inventories, which most think will translate into stepped-up demand for goods down the road.
"The market is telling you that it thinks rates are going higher," said Mark Wanshel, vice president and financial economist at J.P. Morgan Securities Inc.
"We believe that within the next two to three months, the Fed will tighten," Wanshel said. "We're pro-yield curve trades because we believe long-term rates won't go up and that short-term rates will."
Wednesday's beige book report from the Fed may provide the market with some clues about the central bank's leanings where interest rates are concerned, market participants said.
The September bond contract closed down 3/32 at 115.13.
In the cash markets, the 4 1/8% two-year note was quoted late yesterday down 4/32 at 100.03-100.04 to yield 4.18%; the 5 1/8% five-year note ended down 7/32 at 100.06-100.08 to yield 5.20%; the 6 1/4% 10-year note was down 4/32 at 103.00-103.02 to yield 5.83%; and the 7 1/8% 30-year bond was up 4/32 at 107.12-107.14 to yield 6.55%.
The three-month Treasury bill was up three basis points at 3.07%; the six-month bill was up three basis points at 3.29%; and the year bfll was up four basis points at 3.55%.Treasury Market Yields Prev. Prev. Monday Week Month3-Month Bill 3.11 3.13 2.996-Month Bill 3.29 3.28 3.131-Year Bill 3.55 3.58 3.312-Year Note 4.18 4.17 3.913-Year Note 4.47 4.50 4.225-Year Note 5.20 5.21 4.967-Year Note 5.48 5.89 5.3710-Year Note 5.83 5.89 5.7430-Year Bond 6.55 6.67 6.66Source: Cantor, Fitzgerald/Telerate